Cisco's Still a Strong Buy Ahead of Earnings

NEW YORK ( TheStreet) -- Cisco ( CSCO) will report its fiscal third-quarter earnings on Wednesday. Even though it's no longer the days of the tech bubble, you couldn't tell by the company's recent performances. After overcoming some missteps in execution, the network giant has now strung together eight consecutive earnings beats. Investors are anxious to see if Cisco, which still looks undervalued by 25%, can maintain its momentum.

With uninspiring earnings results from several Cisco rivals because of weak enterprise and government spending, it's anyone's guess what Cisco is going to produce. Not only has the U.S. government's sequestration hurt the overall sector but, given that carrier spending hasn't yet rebounded to normal levels, analysts have had no choice but to trim Cisco's estimates in anticipation of weaker results.

Analysts are now looking for earnings per share of 49 cents on revenue of $12.18 billion, which would represent sales growth of 5%. But there are also some upside catalysts here as well. The recent 4G upgrades on U.S. wireless networks from the likes of AT&T ( T) should fuel Cisco's hardware, which should help Cisco's two largest businesses, routing and switching.

That means that although estimates have been lowered due to weak macro events, it's possible that Cisco may offer an upside surprise. That should propel the stock higher. For this reason, I would be a buyer here, especially since the stock has shown a history of jumping by as much as 3% following the company's recent earnings reports, including for its fiscal second quarter when the stock reached a high of $21.46 in the days that followed the earnings announcement.

How Cisco guides, however, will also determine how investors react to the stock. Analysts on average expect fiscal fourth-quarter earnings of 51 cents per share on $12.49 billion in revenue, which would mean 6.7% revenue growth. Given Cisco's historical average of 5% sales growth, I think an estimate of $12.49 billion, which is above my target of $12.35 billion, is a bit aggressive - albeit a positive sign of confidence.

Moving Forward

As evident by these projections, analysts are becoming more bullish on Cisco, whose stock has jumped to its highest level in two years. The Street seems to be warning up to management's strategy to lead the company out of its long-time hardware mindset to more of a "software company." For instance, when Cisco reported second-quarter earnings in February, the stock jumped despite noticeable weaknesses in the company's core routing and switching businesses.

Accordingly, Cisco has spent a good portion of its cash on recent acquisitions for the likes of Meraki, Cariden and BroadHop. So, as the hardware businesses continue to erode, Wall Street is applauding the company's growth and investments in software-defined-networking, or SDN.

Cisco's new outlook has also caught the attention of Raymond James analyst Simon Leopold, who recently said that shares were undervalued by 30%, while applying a $25 price target. In a research note to investors, Leopold said:

"We expect Cisco to outline its strategic vision to become a broader IT supplier with a greater software bias, which aids margin. We expect Cisco maintains its 5-7% long term growth target while offering cautious commentary on the near term."

Leopold's mention of margins suggests increased profitability while Cisco tries to build its SDN business. Besides, even though the hardware revenue and margins haven't been overly impressive, Cisco's hardware still powers more than half of the Internet - meaning, Cisco's transition presents a win-win situation for investors.

As the company continues to invest in its future, the good news is that Cisco is still growing in other areas such as data center, whose revenue rose 65% year over year in the second quarter. That is also a sign that Cisco is still a dominant force in servers where it is outperforming Dell ( DELL) and Hewlett-Packard ( HPQ).

What's more, the company's cash position will continue to present the company with options not available to rivals like Juniper ( JNPR) and F5 Networks ( FFIV). In that regard, when applying modest 3 to 4% free-cash flow growth, the stock still supports a fair market value of $30. That is despite having already gained 7% on the year. Cisco remains a strong buy.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Richard Saintvilus is a private investor with an information technology and engineering background and the founder and producer of the investor Web site Saint's Sense. He has been investing and trading for over 15 years. He employs conservative strategies in assessing equities and appraising value while minimizing downside risk. His decisions are based in part on management, growth prospects, return on equity and price-to-earnings as well as macroeconomic factors. He is an investor who seeks opportunities whether on the long or short side and believes in changing positions as information changes.